VAT system changes call for caution

South Africans can be proud that the country is deemed to have one of the most efficient value-added tax (VAT) systems in the world.

The source of this accolade is the International Monetary Fund (IMF)and it appears in the Davis tax committee’s first interim report on VAT, which was released for comment recently.

But perhaps the most important point in the interim report is that it opens the way for a "moderate” increase in the VAT rate, especially because the committee sees this as having a less distortionary effect on macroeconomic activity than an increase in direct taxes (personal and corporate) would have.

Moderately increasing the VAT rate by, say, 2% to 3% would be less distorting for the economy than raising personal or corporate taxation levels. But there is a caveat. If the government is planning to redistribute the additional revenue generated by the increase on socioeconomic projects to curb the regressivity of increased VAT, it would need to be mindful that the current instruments and infrastructure at its disposal may not be adequate.

According to the tax committee and the IMF, South Africa has a low VAT compliance gap, the difference between the potential net VAT and actual collection. Our gap was estimated to be between 5% and 10% from 2007 to 2012, but the gap in European Union member states was estimated to be 16% in 2012, and in Latin American countries it was estimated to be 27% from 2006 to 2010.

South Africa’s policy gap – the difference between theoretical revenue and potential revenue – was also found to be comparatively low. It was estimated to be between 27% to 33% from 2007 to 2012, whereas the average in the EU was 41%.

Two factors that contributed to the comparative efficiency of our VAT system was the limited number of exemptions and zero ratings, which assisted in the smooth administration of the system.

But the South African Revenue Service and the treasury need to pay more attention to the analysis of revenue collection weighed against a theoretical broad base, taking into account noncompliance and policy objectives.

I agree with the IMF’s observations and recommendations about what the South African tax authorities could consider. These are:

Continued monitoring of the VAT compliance gap to evaluate its performance and to inform strategic decisions;

Updating the estimated VAT gap and sectoral composition;

Broadening the tax gap analysis to include other major taxes;

Increasing the integration of revenue and national compliance analyses to support systemic compliance risk management; and

Carrying out more detailed analysis of revenues from individual industry sectors and taxpayer segments to support strategic risk research.

On the subject of zero rating of VAT, a detailed economic analysis should be done on the constitution of the basket of zero-rated goods. Although zero rating can score some political points, it is not the ideal instrument to benefit the poor, and I do not believe that other zero-rated items should be considered.

Rather, a reduction in, or the elimination of, the basket of foodstuffs that qualify for zero rating should be considered.

I agree with the recommendation that dual or multiple VAT rates should not be considered as they could lead to manipulation, complexity and increased cost of compliance.

For a number of sound reasons, exemptions in a VAT system should be kept to a minimum and only be used for difficult-to-tax goods or services, or for solid economic reasons.

Before any new concepts are considered for introduction into the VAT system, it is vital that the complexity and compliance costs of these should be examined in detail.

This includes the possible introduction of concepts such as self-supply taxing mechanisms; applying zero ratings to the supply of financial services; reduced input tax credit models; options afforded to financial institutions to tax financial services to taxpayers who may claim VAT as input tax; VAT grouping; and the reinstatement of intermediary services supplied to financial institutions.

When it comes to place-of-supply rules, these should be considered for the VAT system, but any recommendations need to be underpinned by international literature and experience. It would be important for these recommendations and analyses to compare how worldwide and local systems treat the place of supply.

In the case of telecommunications and e-commerce, there is definitely a need for more clarification and for consideration to be given to the distinction between business to business and business to consumer.

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